Who will be bagging e-business VAT?

On 27 November the finance ministers of the European Community member states told the commission to go away and think again. So what went wrong?

As expected, the main sticking point was money. The commission’s proposals would have allowed each non-community supplier to pick a single member state and register there. That member state would then have collected all the VAT on sales to consumers everywhere in the community.

Registrations would not have been spread evenly around the community.

Everyone would have piled into Luxembourg, with its low 15% VAT rate, or into the UK because of the English language. Not much VAT would have gone France’s way, and none would have ended up in Sweden with its 25% rate.

Member states get upset when they do not receive VAT which they think belongs to them, because it arose on sales to their consumers. And the solutions proposed focused on sharing the money out in a way which looked fairer.

One solution was to make non-Community suppliers register for VAT in all member states where they sold to consumers and to pay the VAT on sales to those states individually. Another was to have all the VAT flow to one state, but to make that state pass it on to the states where the consumers lived.

Those schemes would address the political concern, but at the cost of making suppliers do more work. They would either have to deal with 15 VAT authorities, or supply one authority with information on the location of customers. Given that the community cannot force outsiders to do anything, it would be unwise to ask them to do something complicated.

But there is another consideration lurking in the background. At the moment, a community supplier of digitised products only charges VAT under the rules of its own member state. For example when a UK company sells software to a French consumer and sends it directly over the web, only UK VAT applies. The French exchequer makes nothing even though the consumer is French.

A non-community supplier can choose to join the same system by establishing a business operation in a member state of its choice. Suppliers which want to comply might do just that if the alternative were registration in 15 member states, or supplying information on the location of their consumers to one state.

It is not as simple as it sounds. A company which establishes itself in a state for VAT purposes could end up being taxed on its profits in that state. But a bit of tax planning should reduce the additional tax cost to something bearable.

So the option of establishment is one that will appeal to large multinationals, which have the resources to allow for the tax planning. But it is those large groups who are most likely to care about compliance. Smaller foreign companies are more likely to ignore the community, because it cannot enforce its tax laws against outsiders.

I therefore speculate that attempts to make the VAT end up in the member states of consumption will be futile. Any attempt to do it will create an administrative burden so great that large businesses will opt for establishment in a single member state, and smaller ones will do nothing.

But there is another possibility which is too horrible to contemplate.

That is to take away the benefit of establishment in a single member state.

All suppliers of digitised products could be made to account for VAT in the countries to which they sell their products rather than in their home countries.

That would give the same result as for goods sold by mail-order. For example, a UK business making substantial mail-order sales to French consumers must register and pay VAT in France. But those rules barely work for goods.

We should not extend them to digitised products or to services, even though that is what some countries with high VAT rates want.

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